It was revealed on Thursday morning that Hillary Clinton plans to address the bad behavior of high-frequency traders in the securities markets. I was initially very pleased that any presidential candidate, let alone one of Mrs. Clinton's stature, would take on a serious securities law issue in the midst of a campaign season dominated by sophomoric antics. However, a closer look at Mrs. Clinton's proposal leaves me concerned that the candidate is thinking more like Val, her SNL alter-ego, than a seasoned legislator and policy wonk.
Before I dig into the issues that render Mrs. Clinton's proposal unworkable and put forth my own, I'd like to take a moment to acknowledge the seriousness of the issue. As recently as 2010 high-frequency traders were playing an essential role in our market structure seemingly without any regulator or market insider taking notice.
Memorably, no one recognized their role the "Flash Crash" as the event was unfolding. At one point that day, CNBC journalists were suggesting that street riots in Athens, Greece had sparked the sell-off even though live side-by-side coverage of the events showed the streets of Athens were quiet as the market plummeted. Elsewhere, market professionals "feared the occurrence of a cataclysmic event of which they were not yet aware" was causing the sell-off. Yet there was no terrorist attack or natural disaster. Talk of fat fingers and finger pointing between exchange chairmen filled the airways that night.
Then-SEC Chairwoman Mary Shapiro called the chairmen of the major securities exchanges and other industry insiders to Washington, D.C. two days after the Flash Crash. The group discussed the events of May 6th and their causes. While no clear answers emerged from the discussion, what Shapiro learned in that meeting led the SEC and the Commodities Futures Trading Commission (CFTC) to jointly investigate the activities of high-frequency traders. The SEC-CFTC joint report, along with best-selling books by Michael Lewis and Scott Patterson, ignited a national dialogue about high-frequency traders and their practices. Consensus built around the notion that high-frequency traders' behavior accelerated the Flash Crash. However, it wasn't until earlier this year when regulators and law enforcement charged a U.K. citizen with "spoofing" that we were told manipulative high-frequency trading may have caused the Flash Crash.
With the dangers of manipulative high-frequency traders so real, I applaud Mrs. Clinton for daring to take on the issue. This is the work I expected out of a candidate with her education and experience. However, I am troubled by the ham-handed way in which she is going about the work. In particular, I believe there are two problems with Mrs. Clinton's proposal.
The first problem with Mrs. Clinton's proposal is that it taxes the placement and cancellation of trades by high-frequency traders in blanket fashion. Laying aside the prospect of head-splitting headaches that will be caused by debating the definition of "cancellation" and "high-frequency traders", let's note that this sweeping effect is wholly unnecessary. The actual damage that is caused by high-frequency traders is not placing and cancelling orders generally. It is that they manipulate the market up-and-down through placing and cancelling orders. This practice is known as "spoofing". And Clinton seems to have exactly this bad behavior in mind. A Clinton aide has been quoted as saying, "The growth of high-frequency trading has unnecessarily burdened our markets and enabled unfair and abusive trading strategies." To punish "unfair and abusive" behavior, a tax or other new law is not required.
For over 80 years, our securities market regulators have had the ability to punish the behavior that Mrs. Clinton wants to address with a new tax statute. Section 9(a)(2) of the Securities Exchange Act of 1934 states that it shall be unlawful for any person to make a series of transactions in a security, manipulating the market by "creating actual or apparent active trading in such security, or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others." This law quite clearly gives the SEC the ability to punish high-frequency traders who engage in "unfair and abusive" trading practices like spoofing.
It would surprise many listening to Mrs. Clinton's proposal that since the Flash Crash in 2010 the SEC has had success in using Section 9(a)(2) to punish high-frequency traders. The settlements with Visionary Trading and Trade Alpha are just two examples of complete enforcement actions that fit this description. With the development of new tools like the Consolidated Audit Trail, there is a sense that the SEC has increasing ability to find and punish high-frequency traders who spoof the market.
Although there are statutes and tools in place to punish high-frequency traders who manipulate the market, there is room to improve enforcement. The primary opportunity to do so is through more meaningful penalties. In the two successful enforcement actions referenced above, the maximum sanction assessed against any individual was a suspension from the industry for 3 years. I believe allowing these fraudsters to reenter the securities markets in which so much American wealth is invested in unacceptable. Mrs. Clinton and others who would hope to reign in high-frequency traders would surely agree that we do not need these individuals active ever again in the markets where pensions, 401k's, and college savings accounts are invested.
This acknowledged need for action leads us to the second problem with Mrs. Clinton's proposal: It is perhaps the most impracticable method for reigning in the manipulative behavior of high-frequency traders available. Instead of going through an inactive and overly partisan Congress to get a tax statute passed, Mrs. Clinton, as President, could curb the abusive practices by instructing the SEC to adjust its approach to spoofing enforcement actions. The simplest response, and one for which there is both precedence and contemporary support, is to insist on more stringent penalties. This includes the imposition of lifetime bans against high-frequency traders who ignore well-established law and repeated warnings to engage in spoofing that is destroying confidence in the U.S. securities markets.
Because my proposal does not involve the writing of a new statute or even a formal rule, the SEC can implement it immediately. The SEC simply needs to exercise its discretion by raising the punishment it negotiates or litigates with those who violate the current law. This wouldn't be the first time that the SEC has used increased punishment rather than legislation or rulemaking to affect changes in market practices.
Tougher negotiated settlements by the SEC could not possibly come as a surprise to high-frequency traders. Aside from the recent campaign promises of Mrs. Clinton and the longer-held positions of Senator Sanders, recent SEC rhetoric indicates it is a strong possibility that the lifetime ban is an option the SEC is actively considering. In fact, SEC Chairwoman Mary Jo White has promised a more aggressive approach to prosecuting market manipulation.
Chairwoman White promised during her confirmation hearing that the SEC's enforcement actions must be "bold and unrelenting." She stated her conviction that "Proceeding aggressively against wrongdoers...also will serve to deter unlawful practices of others who must be made to think twice and stop in their tracks, rather than risk discovery, pursuit and punishment by the SEC." The need for this tough stance, she argued, was that market manipulation is necessary to uphold two of the SEC's mandates -- investor confidence and market integrity.
At the present time, Chairwoman White has the full support some Congressional leaders who are calling on her to back up her rhetoric with action. Senator Elizabeth Warren of Massachusetts in particular has been a strong advocate for tougher enforcement action. In a sharply-worded letter to Chairman White, Senator Warren argued that "the need for strong and effective regulations to protect Americans and their investments is more important than ever." At least two SEC Commissioners share Warren's view and are publicly advocating for more lifetime bans as a deterrent against market abuse.
As this point, with support for action and a simple solution before her, is where Mrs. Clinton's front-runner status and seasoned voice should come into the debate. She should encourage Chairwoman White to show high-frequency traders that "to further strengthen the enforcement function of the SEC" truly is a high priority. If not now, then when the SEC is part of a Clinton administration.